In highly concentrated markets, a small group of companies can generate a disproportionate share of profits. However, when market leadership begins to broaden or volatility increases, such concentration can become a source of risk.
Nvidia's market capitalisation already surpasses that of the materials, utilities, and energy sectors of the S&P 500 index. However, concentration is not limited to specific companies; there can also be a high degree of concentration in various companies and sectors, which can make investors more exposed than they think to a limited set of factors driving returns. This can increase the vulnerability of portfolios when market leadership changes or episodes of volatility arise.
Market concentration tends to be temporary
The concentration of leadership around a dominant theme has been a recurring feature of markets, which rarely has been maintained indefinitely. For example, fossil fuel companies accounted for 29% of the S&P 500 in 1980, while today they represent less than 3%. Between 1989 and 1990, when the boom of the Japanese economy was at its peak, the Japanese equity market represented 44% of the MSCI World index; today it is around 5%. The lesson that investors should learn is that the companies leading the markets at any given time may not be the leaders of the future.
Active managers can rely on analysis and their own judgement to adapt to the evolution of market leadership. Understanding the fundamentals becomes particularly important when enthusiasm becomes widespread.
